Press Room: Tax Release

December 06, 2013

Illinois Supreme Court Decision Shakes Up the Rules for Situs of the Retailer’s Occupation Tax

A recent Illinois Supreme Court decision has held invalid an Illinois Department of Revenue regulation used to determine the local sales tax rates to be applied. The decision opened the door to much uncertainty for any taxpayer required to collect sales tax in Illinois.

The Illinois Supreme Court upheld in-part an Appellate Court decision, abating an assessment of over $23 million in retail occupation taxes, penalties, and interest against a taxpayer. The Supreme Court agreed with the lower court’s decision that the regulations for determining the situs of sales provided for a bright-line test attributing sales within Illinois to where the order was received by the retailer. However, the Court also invalidated the regulation as of the date of the decision, determining that it restricts the scope of local governments’ ability to enforce the tax imposed by the related statute. Additionally, the ruling reversed the lower courts’ holding that the statutes governing the situs of sales within Illinois provide that sales be sourced to the location where sales orders were received. As a result, taxpayers must now look to the totality of their business operations in determining the situs of sales for retailer’s occupation tax (ROT) purposes.

Hartney Fuel Oil Company’s (Hartney) home office is located in Forest View, Illinois (Cook County), from where nearly all of the day-to-day operations take place. Hartney also has a sales office, located in Mark, Illinois, in Putnam County, where all customer orders are accepted. The Mark office consists of one employee, who receives customer orders via phone and relays the purchase order to the company’s common carrier, Energy Transport. The Forest View location is not involved in this process in any way. All long-term contracts of Hartney are signed and kept in the Mark office as well.

The Illinois Department of Revenue (Department) audited Hartney’s selling activity from January 1, 2005 through June 30, 2007, and issued a notice, claiming the proper situs of Hartney’s sales to be the Forest View location. Hartney claimed, and both the circuit and appellate court’s agreed, that the Illinois statutes and regulations provide for a bright-line test, under which sales from within the state to a customer within the state are sourced to the location where the seller accepts the purchase order. Accordingly, Hartney sourced all of their sales to the Mark location, where there is no municipal or county level sales tax. In doing so, they were able to lower their applicable sales tax rate by 2.75%, avoiding tax in Forest View (1%), Cook County (.75%), and from the Regional Transportation Authority (RTA) (1%).

After reviewing the case, the Supreme Court ruled that the lower courts had erred in their determination that the applicable statutes created a bright-line test such as Hartney claimed. The three taxes in question, the Home Rule County Retailers’ Occupation Tax Act (55 ILCS 5/5-1006), the Home Rule Municipal Retailers’ Occupation Tax Act (65 ILCS 5/8-11-1), and the Regional Transportation Authority Act (70 ILCS 3615/4.03), all impose tax on the business of selling at retail, which was defined in Ex-Cell-O Corp. v. McKibbin (1943).That definition holds that selling is made up of the composite of many activities and that it is necessary to determine each case according to the facts which reveal the method by which the business is conducted. From this, the Supreme Court ruled that the local ROT statutes are intended to allow taxation upon the composite of selling activities within each jurisdiction, and not solely focus on where the purchase order was received.

The regulations however, contain much more concise language in providing guidance on how sales should be sourced for ROT purposes. Some of the most applicable language is contained in Ill. Admin. Code 220.115(c)(1).  It states that: which states the seller’s acceptance of the purchase order is the most important single factor in the occupation of selling and that if a purchase order is received by the seller’s place of business within the home rule county, the seller incurs Home Rule County Retailers’ Occupation Tax liability in that home rule county provided that the sale is at retail and the purchaser receives the physical possession of the property in Illinois. While the Court determined the regulations impermissibly narrowed the local ROT Acts and deemed them invalid on a prospective basis, it also ruled that under these standards, all of Hartney’s sales were correctly sitused to Mark and Putnam County, and that the state was bound by its flawed regulation. Further, the Court indicated that since the taxpayer relied upon the regulations, it was entitled to an abatement of the assessment.

While this was a win for the taxpayer in the case at hand, it is for all intents and purposes a loss for taxpayers who would benefit from this situation prospectively. Since the statute was deemed to not provide for a bright-line test and the regulations were struck down, taxpayers will now be required to source their sales based upon the composite-of-activities standard established in Ex-Cell-O. Additionally, there is little guidance currently available on how to apply that standard. In its decision, the Supreme Court stated that the General Assembly was the correct forum for defining such a single-factor test for the determination of retail occupation tax situs; and until they weigh in on this matter there will likely be significant debate over how taxpayers should be determining the situs of sales when computing their ROT liabilities.

Illinois taxpayers will need to evaluate the Illinois ROT rate determinations on a prospective basis. With respect to complex transactions, many unanswered questions arise, such as:

  • What is the proper test for determining sourcing and how does one analyze the totality of the business operations? 
  • If multiple locations are involved, how does the taxpayer determine the situs for local ROT?

It is possible the Illinois General Assembly could enact legislation providing more clear guidance, but any legislative change would likely take at least a few months. In the meantime, consideration should be given to managing risks associated with the improper determination of the local sales tax rate. In some situations, it may be appropriate to collect the highest municipal rate, in other situations it may be appropriate to collect the local tax using the rate for the locality in which the highest business activity occurred considering marketing, selling and other business operations. The decision on where to collect tax is very fact dependent, and will not be the same for each taxpayer.

WTAS can assist you with the many tax complexities that relate to the uncertainty as a result of the Illinois Supreme Court’s decision. Our State and Local Tax professionals can assist with compliance requirements, consulting and planning opportunities when it comes to such matters.